The Market Implied Probability of Government Intervention in Distressed Banks

Neuberg Richard,
Columbia University

Glasserman Paul,
Columbia University

Kay Benjamin,
United States Department of the Treasury

Rajan Sriram,
United States Department of the Treasury

New contract terms for credit default swaps (CDS) on banks were introduced in 2014 to cover losses from government intervention and related bail-in events. For many large European banks, CDS spreads are available under both the old and new contract terms; the difference (or basis) between the two spreads measures the market price of protection against losses from certain government actions to resolve distressed banks. We investigate cross-sectional and time series properties of this basis, relative to each bank's CDS
spread. We interpret a general decline in the relative basis as a market perception that governments are less likely to bailout banks in distress, but that banks do not yet have sufficient bail-in debt to protect senior bond holders in case of a credit event.